OH, THE JOYS of summer. Unpredictable weather, economic turbulence, phone-hacking scandals, combined with rioting and instability in the heart of many of our major cities are all making the summer of ’11 one that we’ll remember for a very long time for all the wrong reasons.
Adding to the potential dismay of some finance directors and company accountants is the fact that they are being (or soon will be) presented with a new valuation of their company’s pension scheme. Setting aside the grim state of many company pension pots, there is the real challenge that now follows of striking the right balance between the needs of the company and its pension scheme trustees. In what can appear to be a conflicting agenda, the interests of its members – being represented by the scheme trustees – have to be weighed up alongside the long-term financial health of the company.
As part of the valuation process, the trustees of most schemes are required by law to agree a funding plan with the sponsoring employer within a 15 month period of the valuation date. With these preliminary results now hitting many company desks, it is a good time to focus over the coming weeks and months on how to get this balance right.
It’s changed days from a time when the scheme trustees simply followed an instruction from the sponsoring company and came to a funding agreement over a few glasses of brandy during a cosy fireside chat. Trustees are now expected to independently and robustly negotiate with the employer to achieve a strong funding target and, where applicable, the speedy removal of any deficit.
That means that an equally robust approach needs to be taken by the management team of the employer to protect the interests of the company and ensure that the demands of the pension scheme do not detrimentally affect operations and continued viability of their business. This is where the critical balance needs to be struck. If the pension scheme is not suitably funded the company could find itself facing a black hole over a period of time. On the other hand, an onerous funding plan could bring on cash flow and other financial problems, meaning the entire pension scheme may ultimately fail if the employer is not able to stay in business.
Given the sensitivities hanging over an employer as they approach the valuation and the negotiations with trustees, I am pleased to offer some straightforward ‘Dos’ and ‘Dont’s’ for this process.
Starting with the Do’s:
1. Make the starting point for the valuation based on the assumptions set out in the current statement of funding principles: the company needs to understand the effect of any proposed changes to valuation calculations and this can only be done by seeing the ‘no change’ position. Also, you should ensure that separate negotiations take place on the technical provisions and the recovery plan as the assumptions for both should be different.
2. Ensure that margins for prudence do not creep into the funding plan in unexpected places: only the discount rate and life expectancy assumptions should be prudent. Best estimate assumptions should be used elsewhere otherwise the basis will be overly prudent and you will potentially overfund your scheme, possibly to the detriment of business operations.
3. Think small: small assumptions can also make a big difference in getting the valuation process right. Look at areas such as percentage married assumptions and cash commutation.
4. Get real: ensure any deficit is funded based on the expectation of realistic rather than prudent investment returns. Also keep any margins for prudence out of your FRS 17 figures as it is very difficult to argue that trustees should take out margins that are presently in the FRS 17 numbers.
5. Look for specialist advice: I would always recommend that you seek an independent view to assess the affordability of contributions. The Trustees will take their own advice on this. So, by taking pro-active advice from your bank or other professional services firms can help set maximum contributions and help persuade the Trustees that your proposed funding plan is reasonable.
And here is what you do not want to do when undertaking this important process:
1. Do not rely solely on the advice of the trustees’ actuary: he or she has a statutory role to act on behalf of the trustees and not the employer. The company may also wish to consider separate investment consulting advice in order to put investment strategy proposals to the trustees.
2. Do not accept things as they are: challenge the advice of the existing or, where relevant, the previous actuary – it may no longer be appropriate. For example, most liabilities are long-term and currently long-term interest rates are higher than short-term ones. Therefore using discount rates derived from short-term gilt yields are unlikely to be appropriate.
3. Do not act as a trustee if you are also acting on behalf of the company: if you are currently a trustee alongside your FD or accountancy role it will be difficult to act in the best long term interests of both members and the company. Accepting this – which may lead to appointing an independent trustee – can actually smooth the valuation process and obtain an efficient, speedily negotiated solution.
4. Do not agree to the method and assumptions without seeing the results: this sounds simple but the valuation process means that the actuary will provide advice to the trustees on assumptions before carrying out the calculations. Therefore you should make clear to the trustees that no agreement will be reached on the assumptions until the preliminary results are available.
5. Do not feel pressurised to meet deadlines in negotiations and don’t fear the Pensions Regulator: it is the trustees who are required to complete the valuation, not the company.
While these tips may offer an advisory guide, just how you follow them and how thorough you are in rolling out this process will determine its ultimate success for both the scheme’s members and the sponsoring company.
Alan Collins is head of corporate advisory services at Spence & Partners
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